Epic Price Reversal for Commodities in 2014

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

If you want to know what happened in 2014 with regard to gold and oil, it’s important to appreciate the inverse relationship between the U.S. dollar and commodities. The following chart is a good place to start:


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Commodities Were Best Performers for FIrst Half of 2014, But the Strong U.S. Dollar Put Pressure on Commodities in the Second Half

Whereas total returns for the S&P 500 Index and 10-Year Treasury bond stayed relatively stable throughout the year, commodities and the U.S. dollar both made an incredible about-face starting around late June, early July. If you don’t factor in China’s renminbi using purchasing power parity, the dollar is the world’s strongest currency. As I’ve written about on multiple occasions, this has weighed heavily on the commodities we track very closely and report on here at U.S. Global Investors, especially gold and crude oil.

According to BullionVault, in fact, 2014 was the worst year for commodities since 1986, when they gave back 8.85 percent.

That being said, let’s open up the Frank Talk archives and look back at the most important commodity stories of 2014.

Oil Dropped Nearly 50 Percent Since the Summer

It should come as no surprise that oil dominated the news in the second half of the year. Since its peak in June, when West Texas Intermediate (WTI) crude was priced at around $105 per barrel, oil has tumbled nearly 50 percent to settle in the mid-$50s. We haven’t seen a decline such as this since the financial collapse of 2008 and 2009.

So how did prices get here? How did they fall so steeply, so unexpectedly? It’s been a perfect storm, to be sure.

For one, the U.S. shale boom has brought about what some call an oil glut in the market. The Saudis have resisted oil production curbs with the intention of undercutting the world’s competition, namely the U.S., Russia and fellow members of the Organization of the Petroleum Exporting Countries (OPEC).

Global growth and the Purchasing Manager’s Index (PMI) are also cooling, leading to tepid demand for oil. As I’ve mentioned on numerous occasions, when the one-month moving average for the global PMI falls below the three-month moving average, WTI crude has fallen 100 percent of the time six months later. Though past performance can’t predict future results, history illustrates a convincing trend.

Commodities and Commodity Stock Historically Rose Six Months After PMI Cross-Over
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And finally there’s the strong dollar, which has historically put pressure on commodities, most notably crude.

Year Over Year Percent CHange Oscillator: WTI Crude vs. U.S. Dollar
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Granted, battered oil prices have led to cheap gasoline, giving consumers all around the globe a welcome tax break this holiday season—a $330 billion tax break, to be exact.

But many oil companies involved in hydraulic fracturing, which is a pricier process than more conventional drilling methods, are starting to feel the pinch. Several companies have already been forced to temporarily close rigs in pricier shale regions, including the Eagle Ford in Texas and Bakken in North Dakota.

As calamitous as this might appear, there are still investment opportunities aplenty. In this recent Frank Talk, I took a contrarian view, arguing that, because oil stocks are currently priced so reasonably, now might be the time to pick up some exposure to this space. As I wrote:

For far too many investors, by the time they gain back the confidence to put money into oil stocks again, the rally might have already taken off, making it challenging to capture the full benefit of the upswing.

And there’s reason to believe that prices will normalize sooner rather than later. Brian Hicks, portfolio manager of the Global Resources Fund (PSPFX), stated that “oil prices are below where they should be, and hopefully they’ll start gravitating back to the equilibrium price of between $80 and $85 a barrel.”

Gold Found the Support Where Oil Didn’t, Was the Second-Best Currency of the Year

Like oil, gold was punished in the second half of the year because of the strong dollar. In the following chart, from an October Frank Talk, you can see just how much of an impact the greenback has had on the yellow metal this year alone:

Strong Contrast in 2014 Gold and Dollar Changes vs. Historic Averages
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In this Frank Talk, posted in June, I wrote:

There is always an emotional bias against gold, whether it is soaring high or dipping low, and that is why it’s important to manage these emotions when positioning a portfolio. At U.S. Global Investors we look objectively at the action of both gold stocks and gold bullion by monitoring these long-term data points and paying attention to buy and sell signals based on the trend of mean reversion.

This, of course, was back when gold bullion was priced at above $1,300. Since then it’s slipped nearly 10 percent, which might have discouraged some gold bugs.

But according to a recent article from Hard Asset Investor, gold was actually the second-best-performing currency of the year, second only to the U.S. dollar:

Given the strength of the dollar, it’s surprising that gold has held up as well as it has. At current prices, gold is only down 2 percent year-to-date, which is actually the best performance of any of the major non-fixed currencies.

Gold is Second Best Performing Currency of 2014
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Before gold and other commodities began to slump, they were actually performing very well, as I mentioned at the beginning of the piece. Back in July, this is what it looked like when you compared gold spot prices and the NYSE Arca Gold BUGS Index:

Gold Mining Stocks Are Beating Bullion (Year-to-Date Performance)
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For the first time in two years, gold mining stocks were beating bullion, which was good news for both the commodity and equities. When miners do well, gold has tended to follow suit.

But then in mid-summer, prices began to fizzle. When you chart the two asset classes for the remainder of the year, this is what you get:

But as Gold Prices Declined, So Did Gold Mining Stocks
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The problem is that when spot prices are between $1,000 and $1,200 an ounce—which is now the case—it’s challenging for miners to break even in terms of cash flow. Gold royalty companies, however, continue to impress. Royal Gold has returned 39 percent year-to-date, while Franco-Nevada has delivered 22 percent.

According to Ralph Aldis, portfolio manager of the Gold and Precious Metals Fund (USERX) and World Precious Metals Fund (UNWPX):

Much of the gold mining industry is underwater and can’t make money with these prices. We’ve seen capital programs being significantly cut back, in terms of companies looking to expand and build new mines. That’s all been put on hold. Those companies have been sufficiently scared enough that, even when gold prices do recover, they’re

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